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The Case Against Baxter International

October 06, 1991

The Corporation

THE CASE AGAINST BAXTER INTERNATIONAL

Even by the standards of most chief executive officers, Baxter International Inc.'s Vernon R. Loucks Jr. sports the whitest of white-shoe credentials. At Yale University, he was inducted into the Skull & Bones secret society, which counts such high-powered initiates as President George Bush. Then, after a two-year stint in the U. S. Marine Corps, he headed off to Harvard business school, where he graduated in 1963.

These days, however, Loucks's white shoes are looking scuffed. In the past 18 months, his company has become the target of two investigations. In Chicago, a federal grand jury is hearing evidence to determine whether Baxter--the world's largest hospital-supply company--violated federal antiboycott law in an effort to get its name removed from an Arab League blacklist of companies doing business with Israel. Documents obtained by BUSINESS WEEK and under examination by the U. S. Attorney for the Northern District of Illinois suggest Baxter may have illegally provided information about its Israeli operation and pledged to Arab League officials not to do business with Israel. Fred L. Foreman, U. S. Attorney for the Northern District of Illinois, declines to comment.

Baxter is also under scrutiny on the home front. On Sept. 6, the company revealed that the Health & Human Services Dept. was investigating allegations that it paid kickbacks to doctors who referred medicare and medicaid patients to Caremark Inc., its home health care unit. Such payments could represent violations of the Medicare-Medicaid Antikickback Statute (page 110).

BESIEGED. Baxter has been under fire since May, 1990, when it first acknowledged that the Commerce Dept. was probing its Mideast business activities for possible violations of the Export Administration Act, which forbids companies to comply with foreign boycotts against friendly states. The case has since been referred to the Justice Dept., which is investigating whether Baxter sold its profitable Israeli medical-supply business and agreed to a financially unfavorable deal with the Syrian army in order to get off the Arab blacklist. Previous reports have suggested that Baxter wanted to get off the blacklist to expand its Mideast business, which currently generates less than $15 million a year in sales.

But BUSINESS WEEK has learned that investigators believe Baxter wanted to get off the blacklist in order to pursue a far more lucrative joint venture with Nestle, the Swiss food giant. Nestle, which has a substantial Mideast business, did not want to alienate its Arab customers by teaming up with a blacklisted company, according to an individual with direct knowledge of the negotiations between Nestle and Baxter.

In April, 1989--three months after Baxter's removal from the blacklist--the two companies publicly announced the formation of Clintec International to develop and market clinical-nutrition products worldwide. U. S.-based Clintec currently has more than $300 million in sales. The timing of the Clintec announcement has caught the government's notice, and, according to a source close to the investigation and several individuals who have been questioned by the U. S. Attorney's office, the government's investigation extends to top executives at Baxter's Deerfield (Ill.) headquarters as well as the highest levels of Nestle and Clintec.

Loucks denies any allegations of wrongdoing. He admits that his company's ventures into the murky Mideast market and the largely unregulated home health care field have been risky. But he asserts that they were calculated risks, taken only after soliciting the advice of top outside legal counsel, including former Secretary of State Cyrus R. Vance, who has served as a Yale trustee with Loucks. The investigators, the 56-year-old Loucks suggests, are likely to come up empty-handed. "There's been no notification they're going to prosecute us under criminal statutes," Loucks says. "They can do anything, you know, including drop it."

Baxter's chairman clearly hopes this will be the case. But BUSINESS WEEK has learned that the U. S. Attorney may seek indictments against the company. A Capitol Hill source with direct knowledge of the investigation says the expected indictments of both the company and individual executives could be based on charges that extend beyond alleged boycott violations. Such charges may include allegations of bribery and other violations of the Foreign Corrupt Practices Act as well as potential violations of Securities & Exchange Commission regulations. Baxter denies it paid bribes or violated securities laws.

HIGHLY RISKY. Why was Baxter so eager to get off the blacklist? By the mid-1980s, Baxter executives recognized that opportunities in the Mideast region were limited and risky. Instead, a source close to the investigation and several individuals who have been questioned by the U. S. Attorney's office say, Baxter needed to sever its ties with Israel and get its name off the blacklist to launch its potentially far more lucrative joint venture with Nestle in the fast-growing $2 billion clinical-nutrition market.

Getting off the blacklist was an explicit condition of the joint venture, according to a source with direct knowledge of the negotiations between Nestle and Baxter. "Nestle had basically stuck a gun in their gut and said: `Get off the blacklist,' " says another source with knowledge of the investigation. "Baloney," says Francois-Xavier Perroud, assistant vice-president of Nestle, who unequivocally denies that Nestle exerted any such pressure.

Clintec's CEO, Richard B. Egen, acknowledges that the government appears to be keenly interested in the joint venture. "I'm aware that they've asked for a lot of documents involving Clintec," he says. Egen says that top executives from Baxter and Nestle were intimately involved in the formation of the venture. "This was very much Vern's idea to set up Clintec," he says.

Nestle and Baxter had been quietly working together since 1986, when Nestle transferred more than $50 million in assets to Baxter in return for its agreement to distribute Nestle's clinical-nutrition products in the U. S. The companies did not publicly announce their arrangement. The 1989 joint venture expanded the agreement into a 50-50 partnership aimed at overseas markets. In contrast to the 1986 arrangement, this deal was loudly trumpeted to the press. Baxter says it kept fanfare before 1989 to a minimum until it was sure that Clintec would fly.

Since 1989, Clintec's sales have soared, partly because of a spate of European acquisitions this year. From $120 million, Clintec's sales have climbed to more than $300 million in just two years--a growth rate that far exceeds Baxter's own. As for profits, Clintec's Egen says only: "We're doing extremely well."

Loucks makes no bones about his intense determination since the early 1980s to get Baxter off the Arab League blacklist so it could participate more fully in the Mideast market. One of the objectives he set for Baxter Senior Vice-President and General Counsel G. Marshall Abbey in 1987 was to find a way to do just that. To that end, Abbey, who reported directly to Loucks, headed a low-profile campaign known by top Baxter executives as "The Syria Project." Abbey was also part of the small circle of top Baxter and Nestle executives involved in the Clintec negotiations.

According to a source with direct knowledge of these events, Abbey briefed the group at the start of most sessions on what was euphemistically called "The Obstacle," bringing negotiators up to date on Baxter's progress in getting off the blacklist, The group included Clintec's Egan and Nestle's top marketing officer, Camillo Pagano, who was not available for an interview. "By that point, Vern had lost the illusion that there was a grand market in the Middle East. There was no pot of gold sitting in the sand," says this source. "Nestle was very clear that it would not go ahead with the joint venture unless the boycott issue was resolved. Vern knew this was the condition."

Loucks denies that he was present at any negotiation where such a condition was discussed. He defends Abbey, who he says was present at these meetings, as well. "I stand by Marsh on this thing," Loucks says. Abbey is traveling and unavailable for comment, but says through a spokesman that he has committed no wrongdoing.

HARD-LINE COUNTRIES. Baxter's Mideast odyssey began in 1969, when it set up Travenol Laboratories (Israel) Ltd. to distribute its products. Two years later, the company built a plant near Ashdod, about 25 miles south of Tel Aviv. The facility manufactured intravenous solutions, blood-collection devices, and other products. In 1975, Baxter learned that the Arab League had placed it on the blacklist of countries doing business with Israel. It tried to get off the list almost immediately. But in 1977, while Vance was Secretary of State, the U. S. passed the antiboycott law.

The law says that while it is not illegal for a company to try to get off the blacklist, it must do so in a way that doesn't comply with the Arab boycott of Israel. The catch was that in hard-line countries such as Syria, the only apparent way to get off the list was to sever all ties with Israel, according to a former Baxter executive. And Baxter had no luck with a number of attempts over the years to invest in Saudi Arabia, which it considered among the more moderate Arab nations.

To get off the blacklist legally, Baxter needed a legitimate business reason for selling its Israeli operation. But in the early to mid-1980s, Baxter's Israeli business was turning a fair profit. In 1987, the year before it was sold, it earned $1 million on sales of $19.5 million, a 5.1% return on sales. That year, by comparison, Baxter itself earned $331 million on sales of $6.2 billion, a 5.3% return.

Baxter says it decided to sell because growth opportunities were limited. The problem, says David N. Jonas, the former general manager of the Israeli business, was that the company had nearly 90% of its market. "Where do you go from there?" asks Jonas, who is now Baxter's vice-president for corporate development. The operation was sold to Teva Pharmaceutical Industries Ltd. in February, 1988, for $19 million.

In the meantime, Baxter's Abbey was working on the Syria project. Loucks says he believed the company could get off the blacklist while complying with U. S. law by making a "parallel investment" that was greater than or equal to Baxter's Israeli business in an Arab country. With no luck in more moderate countries, Baxter leapt at the chance to build a plant as part of a joint venture with the Syrian army. The Syrian market was admittedly risky, small, and politically volatile. Yet the Arab League's boycott office was headquartered in Damascus, and a successful venture in Syria might persuade Arab League officials to remove the company from the list.

Baxter first petitioned to do business in Syria as early as mid-1986, according to an internal company document. By January, 1988, Baxter's Swiss affiliate and the Syrian army had begun talks about building the facility. Abbey made at least one trip to Damascus before the deal was struck, meeting with General Mustafa Tlass, the Syrian Defense Minister whom Jewish groups had identified at the time as the author of a venomously anti-Semitic text. A Baxter spokesman confirms this meeting, but says Abbey was not aware of Tlass' reputation.The deal reached between the Syrian army and Baxter in late 1989 is believed to have been highly favorable to the Syrians. Baxter promised to build the plant, provide technology and training, and receive only a "minimal percent" of the profit for 10 years, says a source close to the probe. After that, the entire operation would be turned over to the Syrians. "The bean counters at Baxter called it the Deal from Hell," this source says.

Baxter does not deny that getting off the blacklist was part of the reason it went ahead, but it also says the operation would have been "sufficiently profitable" to make it worthwhile. Loucks says he never saw the contract.

BITTER BATTLE. Baxter confirms that the U. S. Attorney has subpoenaed documents relating to the profitability of the Israeli operation and the contract with the Syrian army. It maintains that selling the Israeli unit was strictly a business decision entirely unrelated to the Syrian joint venture.

But an Arab League memo and internal company documents obtained by BUSINESS WEEK suggest otherwise. These documents were provided by Dr. Richard Fuisz, a former chief executive of a Mideast unit of Baxter who was ousted by Loucks in 1982. Fuisz filed a wrongful-discharge suit against Baxter in 1985 and negotiated an $800,000, five-year consultancy contract from the company the following year, ending the fierce court battle. Acknowledging that he is still bitter toward Loucks, Fuisz says he spent more than $35,000 of his own money to send an agent to Tunis in 1989 to obtain a copy of a memorandum from the Arab League's boycott headquarters regarding Baxter's petition to be removed from the blacklist.

The memo, which Fuisz says was translated from Arabic and notarized at his expense, says that the Arab League had received a Baxter "pledge that in the future neither the company nor any of its subsidiaries will establish companies in Israel, or participate in them, and will not grant them the right to use its name or its technical expertise." Participating in the Arab boycott against Israel in such a way could constitute a violation of U. S. law, according to legal experts. Baxter will neither confirm nor deny the authenticity of the document or the accuracy of its translation. But it was this document that helped spark the Commerce Dept.'s initial inquiry.

Potentially more damaging is a memo from a Baxter subsidiary, International Medical Technology Ltd., to the Syrian army, dated Sept. 16, 1988. This memo, signed by Baxter's Abbey, also appears to suggest a connection between the sale of Baxter's Israeli operations earlier that year and its effort to get off the blacklist. The memo and attached documents detail the terms of the Israeli operation's sale, its profits from 1983 to 1987, and bank receipts showing the transfer from Israel of all those profits. Baxter confirms the authenticity of the document and its attachments.

The U. S. Attorney's Office believes that Baxter provided information about its Israeli operation, in comparison with its proposed Syrian venture, to show the Arab League that Syria was getting a better deal than the Israelis, according to a source close to the investigation.

"We obviously know you have to walk a tightrope to sell on both sides of that fence," says Loucks. "But we feel that we used every avenue known to us to give us advice on that." But since it is illegal to give information about Israeli operations to Arab countries participating in the boycott, Baxter could come in for a pummeling from the U. S. Attorney.

The mounting legal scrutiny threatens to sully Baxter's recent achievements. In 1985, Loucks led a gutsy $3.7 billion takeover of a larger rival, American Hospital Supply Corp. Two years later, he paid more than $500 million for Caremark, Baxter's largest competitor in the home health care market. The restructuring is now paying off: Second-quarter earnings jumped 28%, to $141 million, while sales should reach $9 billion this year. Baxter stock, a laggard in the late 1980s, has climbed 22.9% so far this year, compared with 17.4% for the Standard & Poor's 500-stock index.

But the charges against Baxter are now generating much ill will. The American Jewish Congress and shareholders such as New York City's pension funds, which own more than 1.9 million Baxter shares, have demanded release of a 150-page Baxter report on the alleged cooperation with the boycott.

The report was prepared last year by outside counsel at the request of the board's audit committee. In November, 1990, Baxter released a one-page summary of the report, which concluded that it had not violated any U. S. laws. But at the company's annual meeting in April, New York City Comptroller Elizabeth Holtzman charged that "Baxter's refusal to release this report suggests it has something to hide." Loucks says that the company hasn't released the report on the advice of counsel.

NO IDEA. In June, Baxter said it was dropping plans to build the plant in Syria, defusing some of the issue's explosiveness. "Most of the emotion died when the Syrian thing was canceled," says Loucks, who admits in retrospect that it would have been wiser not to pursue the project and says he had no idea of Tlass's reputation.

But customers are concerned. Alan Weinstein, president of Premier Hospitals Alliance Inc., formerly known as the Consortium of Jewish Hospitals, which bought $142 million worth of Baxter products last year, says the company has been a good partner. But he says that if Baxter is indicted, Premier may have to rethink that relationship.

The pressure on Loucks isn't likely to ease in coming months as the U. S. Attorney pursues the case. Loucks and a spokesman for Abbey both say the government has not informed them that they are targets of the investigation. But Baxter's chairman clearly has pondered this possibility. "If I have to go up against it, I can stand up and comfortably say I have relied on the opinions of people I have confidence in," says Loucks, referring to Vance, who could not be reached for comment, and the company's other outside advisers. "If that isn't good enough, well, yeah, maybe I'll go down. But if I go down, I'll go down with that kind of support."

HOW BAXTER CAME

UNDER SCRUTINY

JANUARY, 1988 Baxter's Swiss affiliate and the Syrian army begin discussions about building an intravenous-solutions plant in Syria

FEBRUARY, 1988 Baxter sells its profitable Israeli hospital-supply business to Teva Pharmaceutical. Three days after the sale is closed, Baxter submits documents to the Syrian army attesting that the transaction has been completed

SEPTEMBER, 1988 Baxter submits documents further detailing its former Israeli operation to Syrian army officials

JANUARY, 1989 Baxter learns that it has been dropped from the Arab blacklist of companies doing business with Israel

APRIL, 1989 Nestle, a company with extensive interests in the Middle East, and Baxter announce they are setting up a 50-50 joint venture, called Clintec International, to develop and market clinical-nutrition products worldwide

LATE 1989 Baxter agrees to a joint venture with the Syrian army to build an intravenous-fluids plant in Syria

FEBRUARY, 1990 The Commerce Dept. launches an investigation into whether Baxter violated U.S. antiboycott law

APRIL, 1990 Baxter signs a definitive agreement with the Syrian army to build plant

FEBRUARY, 1991 The Justice Dept. begins a criminal investigation into charges that Baxter sold its Israeli operation to get off the Arab blacklist

JUNE, 1991 Baxter drops plans to build the Syrian plant

DATA: BWJulia Flynn Siler in Deerfield, Ill., with David Greising in Chicago, Tim Smart in Washington, and bureau reports